Are out-of-favor electric utility stocks worth the investment? Very few are. But these three look like intriguing buys.
It would seem that looking for worthwhile turnaround stocks among the electric utilities would be highly unproductive. And, given the preponderance of out-of-favor electric utility stocks these days, it is.
These companies typically have highly-conservative management that oversee low-growth and stable businesses, whose profits are limited by regulators that focus primarily on reliable electricity at fair prices to consumers. Further, in the current low interest rate environment, most utility shares carry historically high valuations, leaving little opportunity for contrarians.
However, these companies aren’t immune to problems, or to activist investors with ideas about how to improve shareholder returns. Noted activist investor Elliott Management has been active in the sector – it recently launched a campaign to split up Duke Energy, one of the largest electric utilities. Last year, the investor reached a settlement with Missouri-based Evergy that made meaningful changes to its board and its strategic focus, followed by its successfully pressuring Houston’s CenterPoint Energy to add two outside directors, receive a $1.4 billion equity infusion and create a board-level committee to review and redirect its strategy.
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The electric utility isn’t entirely static, either. Growing emphasis on sustainability is boosting solar, wind and other energy sources while pushing out coal-fired generation. President Biden’s proposed infrastructure plans could allocate many billions of dollars (or more) to boost the electricity grid, while a shift to electric vehicles could create a vast new source of demand.
Listed below are three electric companies that have interesting catalysts along with out-of-favor stocks. Some of the names carry high risks, but offer potentially generous returns that would rival turnarounds in any industry.
3 Out-of-Favor Electric Utility Stocks
Out-of-Favor Electric Utility Stock #1: First Energy (FE)
Ohio-based First Energy is primarily a regulated electricity transmission and distribution company with over six million customers in Ohio, Pennsylvania, West Virginia, Maryland and New Jersey. Excitement arrived at this otherwise prosaic utility last July when the Ohio House of Representatives speaker was arrested on federal bribery charges related to legislation to bail out a former First Energy nuclear power company. First Energy’s CEO and other senior executives were fired shortly thereafter, as it appears that First Energy used rate-payer money to help fund the bribery scheme.
While the ultimate outcome is uncertain, and the scandal could spill over into future rate-setting cases, there is a good chance that the utility will reach a settlement with the Department of Justice to put the issue behind it. First Energy has subsequently overhauled its governance and compliance culture, foremost through several key hires from the board of directors (including two Icahn Capital representatives) on down. The company is also selling assets to prevent a possible equity raise. First Energy’s underlying business remains sturdy, providing investors with upside potential and a 4.1% dividend yield.
Out of-Favor Electric Utility Stock #2: Otter Tail Corporation (OTTR)
Based in northwest Minnesota, this company is a rare combination of an electric utility and a manufacturing business. Otter Tail’s power operations have a solid and high-quality franchise, with a balanced mix of generation, transmission and distribution assets that produce about 75% of the parent company’s earnings. An accommodative regulatory environment is allowing the utility to continue to add capacity, although its projected rate base growth is likely to be incrementally slower than in prior years.
The manufacturing side includes four well-managed specialized metals and plastics companies. Here, stronger end-market growth should more than offset rising input prices. Otter Tail’s sturdy balance sheet is investment grade, earnings and cash flow are growing and the company prides itself on steady dividend growth. The unusual utility/manufacturing structure might make the company a target for activists, as the two parts may be worth more separately, perhaps in the hands of larger, specialized companies. The shares trade 15% below their pre-pandemic level.
Out-of-Favor Electric Utility Stock #3: PG&E Corp (PCG)
In early 2019, this California utility filed for its second bankruptcy in 20 years, this time due to costs from the tragic 2017-18 wildfires. The state’s controversial inverse condemnation laws, which create liability for wildfire damage caused by company-owned equipment regardless of fault, only exacerbated problems from PG&E’s bureaucratic culture. PG&E emerged from bankruptcy last July, and now appears to be on the right track. New leadership, provided by the addition of Patti Pape as CEO, is the driver. Pape previously was CEO of Michigan’s CMS Energy, widely-regarded as being among the best-run utilities in the industry. She has bolstered the leadership team by hiring top executives from other exceptional utilities like NextEra Energy and Berkshire Energy, who are upgrading PG&E’s culture and operating effectiveness. While future wildfire liability through inverse condemnation remains, several factors help tame these risks. First, PG&E is working to reduce the chances that its equipment could spark wildfires.
Also, under California’s recent AB 1054 law, the state established a $21 billion insurance fund to provide coverage of wildfire costs. While coverage is by no means guaranteed, the fund provides a valuable buffer against quick-rising and crippling losses. And, in many cases, the utility can recover wildfire costs through its rate base. Although PG&E will never get the valuation of a plain, non-California utility, and the shares carry high risks, the deep discount seems unwarranted given all of the favorable changes underway.
Do you own any utility stocks? How have they performed? Tell us about them below.
*Editor’s Note: This post was excerpted from a recent issue of Cabot Turnaround Letter. To read more, click here.
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